In 2016, the Duke of Westminster’s family was blasted in the tabloids for avoiding paying inheritance tax by using trusts. Sure, in this instance, we’re talking about avoiding paying billions of pounds. That might be why it got some people’s backs up.
But why should it? The approach they took to protecting their family’s money was entirely legitimate. Anyone else can do the same thing. It’s not just the preserve of Dukes and the super-rich! It’s actually very sensible.
What is inheritance tax, and why is there such a big deal about avoiding it?
Under normal circumstances, when someone dies, inheritance tax is charged at 40% on all their assets over £325,000 (plus the new main residence band of £100,000, which we covered here).
When you die, any assets left to your spouse or registered civil partner are exempt from inheritance tax. On top of this, your partner’s inheritance tax allowance rises by the amount of your allowance that you didn’t use, meaning together a couple can currently leave £850,000 tax-free.
However, depending on your circumstances, the threshold value is still less than the value of many family homes. This has led to a view that inheritance tax traps millions of homeowners into giving their wealth to the state, instead of their children. Without any planning, your beneficiaries may be forced to sell assets, such as the family home, in order to pay the bill.
In reality though, there is no need to panic. Inheritance tax is often referred to as a voluntary tax. With a bit of estate planning, there are ways to massively reduce your inheritance tax liability. In many cases, we can eradicate it completely. Roy Jenkins, former Labour chancellor, once described inheritance tax as something only paid by “those who distrust their heirs more than they dislike the Inland Revenue”!
The main aim of inheritance tax mitigation is to reduce the value of your estate. The smaller your estate when you die, the less your inheritance tax bill is likely to be!
There are several ways to do that. These include making a gift to your partner, family, friends or charities, and taking out some life insurance.
One other option, the main avenue chosen by the Duke of Westminster, is to put things into a trust. That’s what we’re going to look at here. Be warned – it can be one of the more complicated options!
Putting things into a trust
A trust is a legal arrangement where you give cash, property or investments to someone else (the trustee) so they can look after them for the benefit of a third party (the beneficiary).
By putting some of your assets into a trust (which you, your spouse, and none of your children under 18 can benefit from), you are removing them from your estate. You don’t own it any more. That means their value normally won’t be counted when your inheritance tax bill is calculated.
You can set up a trust now, or establish one in your will.
There are lots of different types of trusts and they all have their own rules. So it’s vitally important to make sure you choose the right sort of trust. Some of the most common options are:
- Bare trust – gives everything (both assets and income of the trust) to the beneficiary straight away, as long as they are over 18
- Discretionary trust – the trustees have complete power to decide how the assets in the trust are shared out amongst the named potential beneficiaries
- Interest in possession trust – the beneficiary gets income from the trust straight away (and will pay income tax on that). But they won’t have access to the actual assets generating that income yet.
Other benefits of using a trust
- You can retain control of valuable assets until you consider the beneficiary will be responsible enough to manage it. So if you want to avoid your 18 year old children squandering your fortune on parties and fast cars, you can arrange your trust so they won’t receive anything until they turn 25.
- Your beneficiaries can avoid potentially lengthy probate delays.
Things to remember when setting up a trust
- Not all trusts escape inheritance tax. Some types of trusts are subject to their own tax regimes, including inheritance tax
- There may be some Capital Gains Tax due if you transfer certain assets into a trust in your lifetime. There won’t be if the trust is established in your will
- Trustees may be liable for Income Tax at a rate of 45% and capital gains tax at 28%
- If you die within 7 years of making a transfer into a trust your estate may have to pay Inheritance Tax at the full amount of 40%
- Once you have decided who will benefit for a trust, it can be very difficult to change it!
So, as you can see, the rules are complicated, and we’re only scratching the surface here. The last thing you want to do it walk into an immediate tax charge when setting it up! That’s why you’re best of getting advice from an expert. Give us a call – we’re happy to help.